Abstract
This 2006 Article IV Consultation highlights that Ukraine’s fiscal policy in 2005–06 reshuffled resources from higher saving businesses to lower saving households, touching off a consumption boom, which has been reinforced by rapid credit expansion. In 2005, this boom helped to offset the drag on the economy from marked real currency appreciation, weaker steel exports owing to intensified third-country competition, higher business-tax collections, and post-Orange-Revolution reforms, which clamped down on tax loopholes, smuggling, and corruption. The authorities have proven adept at hitting low fiscal deficit targets.
1. Since the issuance of the staff report, more information about 2006 developments has become available, the government agreed with the President to revisit the adopted 2007 budget’s wage and pension increases, and the NBU is considering administrative curbs on foreign-exchange lending. This additional information does not change the thrust of the staff appraisal.
2. Preliminary below-the-line data for 2006 indicate that the general government cash deficit may have reached only 1¼ percent of GDP, compared with 2¾ percent of GDP projected in the staff report. If confirmed by the final data, this overperformance likely reflects a combination of stronger-than-projected cash revenue growth and underexecution of spending; information about end-December VAT refund arrears is not yet available.
3. Despite the budget overperformance, the government borrowed an additional US$600 million externally in December, contributing to international reserves exceeding the staff report’s projection by US$1.1 billion.
4. End-year CPI inflation was contained at 11.6 percent. The undershoot, relative to staff’s forecast of 12.5 percent, reflects legal delays in implementing the envisaged large utility price increases in Kyiv in December.
5. The government and president have agreed to consider additional wage and pension increases in April 2007. The President first vetoed the original 2007 budget law in late-December and only signed an almost unchanged version subject to this condition. His proposals would increase average minimum wage growth in 2007 from 15 to 17 percent, and, based on staff estimates, could add ½ percent of GDP to recurrent spending.
6. In late-December, the NBU discussed with commercial banks administrative options to curb the rapidly rising foreign-currency-denominated domestic bank lending, particularly to consumers. The NBU’s proposals, which are still being developed, could set limits depending on the type of the borrower and the maturity of the foreign-currency loan.
7. The authorities have passed legislation toward WTO accession and expect the WTO to review Ukraine’s accession prospects soon. The ban on the sale or transfer of agricultural land has been extended for one more year, and will now expire in 2008.
8. The proposals to further raise wages and pensions underscore staff concerns that the opportunity to reduce recurrent spending is being missed in 2007. Staff continues to view increases in provisions and in the minimum capital-adequacy ratio as the first line of defense against rising indirect credit risk. Administrative curbs on lending would need to be carefully monitored, including to prevent shifts into less well-regulated markets and instruments.